No new shares is good for banks

NEW YORK – With many banks still reporting massive writedowns and even quarterly losses from bad mortgage investments, it certainly seems like an odd time for financial stocks to rally.

But, amid the many gyrations in the sector’s stocks over the past week or so was a 27 percent pop in Wachovia Corp. after it announced a nearly $9 billion quarterly loss. And a 22 percent jump for Merrill Lynch & Co. after it lost about $5 billion. Investors were also clamoring for shares of Citigroup Inc., JPMorgan Chase & Co., and Bank of America Corp. after they reported pretty dismal quarters.

None of these banks gave any signal that the massive write-offs and charges they’ve taken because of the credit crisis are close to ending. The real motivation behind the rallies might be that chief executives didn’t say they need to sell more stock to keep their banks afloat.

“The CEOs are telling investors exactly what they want to hear,” said Jeffrey Kleintop, chief market strategist at LPL Financial Services. “It is a huge issue. The potential for dilution by companies issuing lots and lots more equity has been a big risk.”

He points out that most investors realize that companies go through good times and bad. That is factored into the stock price. But what investors will never be comfortable with is companies’ issuing new equity to keep their businesses going.

Issuing more stock makes outstanding shares less valuable. Global banks and brokerages have so far written down about $300 billion from worthless mortgage-backed securities and other risky investments, and have raised an equal amount to prop up their balance sheets – without resorting to issuing new shares.

The CEOs of many top American financial services companies have gotten the message from investors. Merrill’s John Thain, Bank of America’s Ken Lewis, Wachovia’s Robert Steel and others have all vowed that selling new stock isn’t part of their capital raising plans.

And it also appears, for the time being, that banks and brokerages have ended their campaign of giving wealthy governments and institutional investors stakes at advantageous terms. In November, Citi said Abu Dhabi’s investment authority had taken a 4.9 percent stake in the company for $7.5 billion, and Singapore’s sovereign wealth fund Temasek Holdings was one of several investors who gave Merrill Lynch a $17.9 billion cash infusion in December.

The financial sector has gone through bad times before. It has rebounded from the savings and loan crisis in the 1980s, and the 1990s began with huge losses from ill-fated real estate loans and then the collapse of Long-Term Capital Management at the end of the decade.

There was no swift rebound in the financials after each of these periods, and analysts don’t expect it will be any different in recovering from the credit crisis. A tumble in bank and brokerage stocks on Thursday, though not as pronounced as their rise over the past few weeks, is evidence that it will be a long time before shares begin trading in a more stable manner.